Small-cap stocks have been on a tear this year, as investors believe a strong domestic economy and lower U.S. tax rates will disproportionately benefit smaller U.S. stocks with faster earnings growth.
Below, three Fool.com contributors share some of their favorite small-cap stocks, two of which sport above-average dividend yields. Here's the case for why you might want to add Braemar Hotels & Resorts (BHR -8.25%), Selective Insurance Group (SIGI -1.02%), and Physicians Realty Trust (DOC) to your portfolio.
This little-known lodging REIT is worth a look
Sean Williams (Braemar Hotels & Resorts): When looking for small caps to consider buying, I want something unique -- and that's precisely what Braemar Hotels & Resorts offers.
Braemar is a public lodging real estate investment trust (REIT), and as you might have guessed, as a REIT it pays out a handsome dividend in order to avoid normal corporate income tax rates. But it's not just the company's 6% dividend yield that's impressive. It's how the company is approaching its new growth strategy that has me excited for the future.
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In particular, Braemar Hotels & Resorts is solely focused on operating and purchasing luxury hotels and resorts. There are two key advantages to this strategy. For starters, focusing on affluent clientele means that there's less of a chance of serious top- or bottom-line disruption when the next economic contraction or recession strikes. Well-to-do vacationers and businesspersons are far less likely to be impacted by hiccups in the U.S. economy.
Additionally, though focusing on luxury hotels and resorts will limit the size of its portfolio, because these properties don't come cheaply, it'll also allow Braemar to more closely improve its existing properties via near-term renovations and long-term cost-cutting. During the first quarter, revenue per available room (RevPAR) in the eight properties it owns not undergoing construction (it owns 12 total properties) increased by 2.3% to $237.21.
Recently, investors have been given a golden opportunity to buy into this beaten-down REIT following one-time costs associated with Hurricane Irma and fires in Northern California that create downtime at a few of its properties. While these events were unfortunate, they're not long-term negatives for Braemar.
What you get with this true small cap is that aforementioned 6% yield, a management team that's using its leverage very conservatively, and a portfolio with the highest RevPAR in the public lodging REIT industry. It's a stock that's not going to knock your socks off, but it looks to be on track to create long-term wealth for patient investors.
A small insurer to keep an eye on
Jordan Wathen (Selective Insurance Group): This small-cap insurance company has everything you want in an insurance stock: Disciplined underwriters, conservative accounting, and executives whose interests are aligned with shareholders.
Selective Insurance Group is primarily a commercial insurer that generates the bulk of its premiums from general liability, auto, property, and workers compensation policies sold by independent agents in 25 states.
Living up to its name, Selective Insurance Group has an impressive underwriting record, generating an underwriting profit in each of the last five years. It's also proven conservative in reserving for losses, as it has consistently benefited from favorable prior-year developments, which occur when an insurer's actual loss experience is better than it initially forecast. (Recurring favorable developments are the hallmark of quality insurance companies.)
Management's financial interests are aligned with shareholders, thanks to a compensation structure that rewards executives based on its underwriting profitability. Priced at about two times book value, Selective Insurance Group may not be an obvious bargain, but I believe it can reliably produce a double-digit return on equity helped by rising interest rates, and, most importantly, retain its earnings to grow premiums over time.
Healthcare real estate: An excellent long-term growth and income opportunity
Matt Frankel (Physicians Realty Trust): While it isn't one of the largest real estate investment trusts (REITs) focused on healthcare, Physicians Realty Trust has a unique investment approach with excellent long-term potential.
Specifically, the "big three" healthcare REITs (Welltower, HCP, and Ventas) have large exposures to senior housing, which is facing a few big issues right now. In addition to oversupply in several key senior housing markets, several senior housing operating companies are in shaky financial condition.
Physicians Realty Trust's portfolio is 100% composed of medical office buildings. Medical offices have the same favorable demographic trends without the headwinds -- specifically, the U.S. population is aging and older people spend more on healthcare. Over the next 20 years, seniors (65 and older) will grow from roughly 15% of the U.S. population to 21%, and the oldest age groups are growing even faster. Also, seniors spend almost three times on healthcare as the average American.
The company owns a portfolio of 265 properties, most of which are medical offices located on healthcare campuses and/or are affiliated with major healthcare systems. Almost all are leased on a triple-net (77%) or absolute-net (16%) basis, which translates to steady and predictably increasing income.
The general strategy the company employs is to leverage Physicians Realty Trust's relationships to find value-adding acquisitions. The company does a great job of finding off-market opportunities, and because of its relatively small size, it can pursue opportunities that would be too small for the largest healthcare REITs.
Physicians Realty Trust pays a generous and sustainable 5.8% dividend yield and has lots of growth potential in the years and decades ahead. Long-term investors who want an excellent combination of growth and dividends should take a closer look at this well-run healthcare REIT.
